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Commission seeks capital shake-up

The latest piece in the EU’s jigsaw of financial markets regulation emerged on 20 July, when European Commission officials presented their proposals for new capital requirements for banks. To help restore stability, the Commission is demanding more volume and higher quality in the capital that banks must hold, so as to spare taxpayers from shouldering the burden if another crisis erupts.

The new rules are a response to the guidelines drawn up last year by the Basel Committee on Banking Supervision, and the EU is the first jurisdiction in the world to act on them. Michel Barnier, the European commissioner for the internal market, who is the official author of this latest Commission initiative, is unapologetic about his desire to create a ‘single rulebook’, with fully harmonised bank rules that must be implemented by every member state.

His thinking had already been criticised, even before these proposals became public. For some, the measures are too tough, for others not strict enough, while some member states fear losing the flexibility to set their own capital thresholds. But Barnier is insistent that only when banks throughout the EU are required to keep the same minimum levels of high-quality capital can stability truly be restored.

His proposal specifies how much capital banks must retain, and introduces a more demanding definition of how that capital is to be constituted. The minimum capital they will have to hold will continue to be set at 8% of their risk-weighted assets. But the proportion of this capital that must be of the highest quality (known as common equity tier 1, or CET1) will more than double, from 2% to 4.5%. In addition, a new “conservation buffer” (designed to prevent a situation in which taxpayers’ money is used for bank resolutions) will be fixed at 2.5%, bringing the total ratio of high-quality capital to 7%.

National regulators will – under the terms of the proposal – lose the right to set minimum thresholds higher than this, which will displease the UK and Spain, the champions of the current flexibility. Barnier counters that flexibility is catered for in the “counter-cyclical buffer”, which will allow national regulators to ‘top up’ the capital requirements in times of economic downturns, or in the face of particular national pressures, such as property bubbles.

One set of rules

Barnier’s focus is clear: “The important thing is that the core requirements, which are not linked to any specific fragility, be the same everywhere,” he said as he announced the proposals. “There is no reason for the core prudential rules to be different in Madrid, Warsaw, London, Paris, Rome and Berlin.” He dismissed as “totally illusory” any national approach to reinforcing bank stability in a single market, where difficulties confronting one European bank have an impact on the whole sector.

Fact File

Basel guidelines

The proposals announced on 20 July follow Basel III guidelines agreed by the Basel Committee on Banking Supervision last year.

In the form of a regulation and directive, the rules will apply to 8,300 banks in the EU.

According to figures published by the European Commission, banks in the EU will need an extra €84 billion of the highest quality capital (common equity tier one, or CET1) by 2015, and €460bn by 2019, assuming full implementation.

In addition to capital, the regulation could contain new rules for liquidity and leverage. Liquidity requirements would be introduced in 2015 after a review period, while a final decision on whether to introduce the leverage ratio as a binding measure will not be made until 2018.

The proposed directive contains rules on:

Corporate governance, setting new standards for bank boards, which officials said could help prevent excessive risk-taking.

Sanctions for banks that breach rules, including the possibility of fines of up to 10% of an institution’s annual turnover.

Enhanced supervision, with more robust standards for supervisory assessments.

A proposal to reduce the reliance by credit institutions on external credit ratings, by requiring investment decisions to be based on banks’ internal opinions.

The intense wrangling between member states is likely to be mirrored in the European Parliament. Philippe Lamberts, a Belgian Green MEP, said the proposals were “too timid”. The minimum capital requirements “fell far short” of recommendations by experts, including the Bank of England, he said.

Most of the capital requirement proposals are contained in a draft regulation, which will have to be approved by MEPs and member states. The plan is for the rules – which will be applied to more than 8,000 banks in the EU – to be phased in between 2013 and 2018.

Additional requirements in the regulation will tighten up liquidity rules (to protect banks from insolvency in the event of a sudden rush by depositors) and may impose a leverage ratio (limiting banks’ ability to fund investments through debt). Other new banking rules, including proposals for the make-up of bank boards and sanctions for those that break the rules, will be dealt with in an accompanying directive.

The banking sector’s concerns relate less to the harmonisation of requirements (particularly if that prevents member states adding higher capital thresholds) than to how tough the requirements are. The European Banking Federation (EBF) said it was “concerned over the impact, especially with regard to liquidity”. Banks’ traditional business model of transforming short-term deposits into long-term lending could become more difficult, restricting the ability of banks to lend, said Guido Ravoet, the EBF’s chief executive. It was vital to “address this major concern and understand the true impact of the new ratios”, he insisted.

Small businesses are also worried that the new rules could hamper bank lending, said Andrea Benassi, the secretary general of UAPME, the European association of craft, small and medium-sized enterprises.

Other pieces of draft financial legislation – on derivatives and short-selling – continue to be bogged down in haggling between member states and MEPs. There is little to suggest that the capital requirements proposals will have it any easier.